ONE OF the key roles of the excess and surplus-lines marketplaceis to function as a “relief valve” during hard markets. Whenstandard insurers start restricting their underwriting or pull outof certain states or classes of business altogether, affected riskshave always been able to turn to the E&S markets. Therelief-valve role was amply demonstrated during the recent hardmarket, when direct premiums for E&S insurers rose by 62% in2002 and a still-healthy 28% in 2003, according to A.M. Best. Atthe end of that year, the E&S market accounted for 13.1% ofcommercial-lines premiums, Best's noted, up from 6.1% a decadeearlier.

In some states, the move to the E&S marketplace was evenmore pronounced. In California, the leading state in the countryfor E&S business, E&S premiums were up 104.5% in 2002 and43.1% in 2003, according to the Surplus Lines Association ofCalifornia. But in 2004, growth dropped sharply to 8.4%, accordingto information the association released in January. Undoubtedly,E&S business was off substantially around the country, asstandard carriers, in better financial shape after several years ofhard-market premiums, began to once again eye business they'd letgo three or four years earlier.

Where will the E&S market go from here? One place to startlooking for an answer is with the reinsurance community.Traditionally, Jan. 1 has been the big date for renewals. Afterreceiving them, insurers get a clearer picture of a key factoraffecting their costs and capacity for the year ahead. TomLeonhardt, senior vice president of Towers Perrin Reinsurance, amajor reinsurance broker, said that when he entered the business 30years ago, practically all reinsurance treaties renewed on Jan. 1.Today, renewals take place pretty much throughout the year, hesaid, but Jan. 1 remains the single largest day for them.

Overall, Leonhardt said, reinsurance rates were “softer” thisJan. 1, with rate reductions most in evidence on the property side,the degree of softening varying by a book's exposure to hurricanelosses. Direct and broker reinsurance markets, including London,are all looking for business aggressively, Leonhardt said, “Sothere's plenty of capacity out there, even for earthquakeaggregates.” After property insurance, he said, reinsurance next ismost plentiful for general casualty insurance and then thetraditionally longer-tail lines.

Leonhardt said it's hard to generalize about the effects ofreinsurance on insurer formation or expansion. Since 9/11, a numberof carriers, some Bermuda-based, have entered the E&S market,but some were backed by very large parents that didn't necessarilyneed much reinsurance support, he said. On the other hand, small,regional E&S insurers with a relatively narrow focus could welluse

reinsurance to expand and are welcome partners for reinsurersbecause of the restricted scope of their coverage. Reinsurers, heobserved, not only provide insurers with surplus relief (givingthem more capacity to write business) but also can provide addedexpertise in lines of business, which can help an insurer grow. Theupshot, he agreed, is that for either E&S or standard marketsthat want to expand into new areas, the reinsurance support “mostdefinitely” is out there. Therefore, reinsurance conditions areright for standard insurers to aggressively take back business fromthe E&S markets-and for E&S insurers to resist, where theywish to.

What are the participants in the E&S marketplace seeing andpredicting? In the remainder of this special report, a number ofcurrent and former leaders of the American Association of ManagingGeneral Agents and the National Association of Professional SurplusLines Offices give their perspectives. Executives of severalprominent E&S insurers and a wholesaler weigh in as well.

Joe Hutelmyer
Seaboard Underwriters

The year ahead for the E&S marketplace likely will becharacterized by caution and slow growth, according to JoeHutelmyer, president and CEO of Seaboard Underwriters inBurlington, N.C. Seaboard, which does business nationwide, focusesexclusively on trucking and other commercial-auto risks. Hutelmyeralso is the current president of the American Association ofManaging General Agents.

Hutelmyer said he has spoken to some E&S carriers that areprojecting 10% growth for 2005. Overall, however, he said theconsensus seems to be for very limited growth, with lower ratesaccounting for negative 5% growth in some lines.

Hutelmyer said he expects competition from standard markets tocome primarily in personal-lines auto and property. In contrast,“We're not seeing any activity coming in on commercial auto orcommercial property,” he said.

In regard to how E&S carriers might respond to competitionfrom standard insurers in the year ahead, Hutelmyer said, “I thinkwe're going to see people picking their spots.” They'll fight toretain the profitable portions of their books, he said, whilelooking to grow where they see opportunities. He believes that theE&S market will continue to fill the void created by the exodusof the standard markets from the small independent agent. He alsopredicted that E&S carriers will be most successful writingprogram business in certain well-defined niches, away from moregeneral risks like manufacturers, contractors and productsliability “unless it's a really tough product.”

To a degree, Hutelmyer said, insurance company executives appearcautious because of uncertainties over such matters as the eventualeffect of the Spitzer investigation into insurance agency/brokercompensation, federal versus state regulation and the implicationsof the federal Sarbanes-Oxley Act for reserve adequacy and otherbalance-sheet issues. “Right now the marketplace is such thateverybody is talking pricing discipline, and actually practicingwhat they preach,” Hutelmyer said. “I think that all it takes isone or two markets that are aggressive, that are looking toincrease market share, to change the attitude. But right now, we'reseeing people hold the line.”

Richard Polizzi, ASLI
Western Security Surplus

While market conditions are softening, E&S carriers for themost part remain disciplined underwriters, according to RichardPolizzi, president and CEO of Western Security Surplus and thecurrent president of the National Association of ProfessionalSurplus Lines Offices.

WSS maintains offices in Pasadena, Roseville and Los Alamitos,Calif., and in Dallas, Texas. “That puts us strategically in thetwo largest surplus-lines states,” Polizzi noted. By design, WSS isa generalist, he said. Besides insuring an array ofcommercial-lines risks, it also writes homeowners insurance andpersonal articles floaters. As an MGA, WSS tends to focus on small,non-manufacturing accounts, he said, while placing the “full gamut”of risks as a surplus-lines broker. About 70% of its business isnonadmitted, and 30% is admitted.

Polizzi said that in the territories he serves, contractors andmany professional risks continue to rely heavily on the E&Smarkets for coverage, and that carriers can still command priceincreases for such business. Manufacturers with major productsliability exposures and aviation risks (although WSS doesn't writethem) also must continue to count on E&S carriers, he said.Accounts with problematic loss histories or locations are amongothers that continue to be served by the surplus-lines market. For“run-of-the-mill risks,” however, market conditions clearly areloosening, he said, and pricing is more flexible. Polizzi said thatone obvious sign of softening in the E&S marketplace is thatcarriers are lowering minimum premiums for certain classes ofbusiness. On the whole, however, he said he finds them maintainingunderwriting discipline.

“I think the difference between the market today and…30 yearsago is that the people who run the E&S carriers are by andlarge…more sophisticated,” he said. “There are fewer markets outthere that are willing to chase premium for the sake of marketshare.

“But they are also realistic, and understand that during thehard market they've had their way, and now things are changing andthey have to be a little more flexible. There are going to beaccounts that are going to go back to the standard market…but thereare other ones they will want to retain, and they will be moreaggressive than they have been in terms of pricing.” Propertyinsurance, he said, is one line that has seen, and will continue tosee, the effects of such competition.

Polizzi said he expects the role of wholesalers to continue togrow, regardless of whether the market is hard or soft, as carrierslook to them to deliver more than niche-oriented products. “Thewholesale industry is supposed to be opportunistic in the bestsense of the word,” he said, “and if a need arises in themarketplace, we're going to take advantage of it.”

Kurt Bingeman, CPCU, ASLI, RPLU
Russell Bond & Co. Inc.

At Russell Bond & Co. Inc., the changing E&S marketplacehas been reflected in a higher percentage of relativelysmall-premium accounts, according to President Kurt C. Bingeman.For the marketplace as a whole, increased competition is leading toa migration of large accounts back to standard carriers and mayprompt E&S carriers to reconsider greater use of admittedpaper, said Bingeman, who also is a past president of the NationalAssociation of Professional Surplus Lines Offices.

Russell Bond is located in Buffalo, N.Y., and operates primarilyin the Northeast. It derives about 40% of its business fromprofessional liability insurance, a line in which it occasionallywrites large accounts, particularly for financial institutions. Onthe whole, however, its clients tend to be small or midsize,Bingeman said. About 60% of its business is nonadmitted and 40%admitted.

Because of a pronounced softening in rates in the second half of2004, Bingeman said his business was up only slightly last year. In2005, he said he's projecting a little more than 10% growth. “We'regoing to have to work hard for that 10%,” he added.

Russell Bond certainly got off to a good start. New-businesssubmissions in the first two weeks of January were up 130% from ayear earlier, Bingeman said, while the number of new policies boundwas up even more, to 150%. But because of today's lower rates,premiums were up only 55%, he added.

The increase in submissions didn't just happen. Bingeman said hehas placed renewed emphasis on marketing. In particular, “we'vetried to get to know our regular producers better,” he said.Russell Bond has expanded out of its traditional New Yorkterritory, he added, and is now writing E&S business inPennsylvania, New Jersey and Connecticut. In response to softeningmarket conditions, the company is contemplating acquisitions as away to enter new territories or acquire new markets, he said.

Bingeman said that when standard insurers start returning topreviously abandoned lines, they usually go after large accountsfirst. That's the case now, he said, as E&S carriers find itharder to hold on to commercial auto and contracting accountslarger than $100,000 in premium.

Another sign of the softening market, Bingeman said, is thatE&S insurers seem more willing to discuss using admitted paper.Just about all the major E&S insurance groups, he noted, haveadmitted as well as nonadmitted companies. During a hard market,E&S carriers tend to use nonadmitted paper almost exclusively,because it offers greater flexibility in regard to terms andpricing. In a more competitive soft market, however, they may beforced to write more business on an admitted basis, he said.

In D&O insurance, a core product for Russell Bond, rates arecontinuing to decrease, Bingeman said, “Although everything I readtells us our D&O premiums should be going up.” In what appearsto be another response to increasing competition, some of hismarkets that write D&O and EPLI for nonprofit organizations noware also interested in writing the rest of their coverages. Whilethat could create some opportunities for MGAs, there also could beresistance from retail agents, Bingeman said. When they can, thoseagents generally prefer to place the auto, GL, property, etc., withtheir agency companies to get higher commissions and credit towardmeeting volume commitments and qualifying for profit sharing.

Not all lines are softening, of course. Program administratorswith which Russell Bond works in the public-entity sector areturning more to nonadmitted paper for products like publicofficials E&O and police professional liability, Bingeman said.Municipalities generally prefer-and sometimes mandate-admittedcoverage, he said, “But if there are not a lot of facilities outthere, I'm sure they'll understand the need to move with themarketplace.”

In today's market, Bingeman said commercial auto continues to bea strong product for Russell Bond. “There are not a lot offacilities for small commercial auto and garage liability,” hesaid. Russell Bond also has been writing more monoline workerscompensation insurance-not usually thought of as a surplus-linesbroker's product-after a couple of major insurers stopped writingthe coverage in the Northeast.

Bingeman said that while he expects growth to be modest thisyear, particularly compared with the hard-market years, he plans tocontinue adding staff. The extra people will be needed to maintainpresent service levels, he said, because while revenue may not goup greatly in 2005, he expects a much higher policy count. He addedthat good service and sound relationships are vital to maintainingthe 95% renewal rate Russell Bond historically has enjoyed fornonprofit D&O and some E&O accounts. To keep that figure ashigh as possible, Russell Bond compensates service staff on thebasis of retention as well as revenue.

In recent years, Russell Bond has invested in imaging and othertechnology, which should serve it as well in a soft market as ithas in the hard market. The MGA also has retained consultants tohelp it identify internal strengths and weaknesses.

“We're still moving ahead,” Bingeman said.

Baron Garcia
Oklahoma General Agency

A softening E&S marketplace is beginning to manifest itselfin such forms as the return of underwriting credits and lowerunderwriting surcharges for certain risks, according to BaronGarcia, president and CEO of Oklahoma General Agency in OklahomaCity, Okla. Garcia, who is a past president of the AmericanAssociation of Managing General Agents, predicted a decided“loosening” in the marketplace later in the year.

Oklahoma General Agency does business in Oklahoma, Arkansas,Kansas and New Mexico. It primarily writes commercial lines,including commercial auto, monoline general liability, monolineproperty and general liability for habitational risks. It alsowrites a gamut of personal-lines products, other than autoinsurance.

About 70% of Oklahoma General's business is admitted, and 30% isnonadmitted. That ratio is practically opposite of what it was justa couple of years ago, Garcia said. He attributed much of thechange to the need to respond to a surge of business during thehard market. “With the admitted markets, for which we had fullbinding authority, it was much easier to quote and get thingswritten than to submit an account for a quote to a (nonadmitted)company that gave us limited or no binding authority,” he said.(Oddly enough, Garcia said that many retail agents also areexpressing a preference for admitted paper out of concern about theSpitzer investigation, although he granted it's hard to see aconnection.)

In regard to the E&S markets, Garcia said nothing seems tobe changing in personal lines, particularly for low-end products.Current rates are holding, he said, and no credits are available.“If we're going to renew it, at best it will be at expiring,” hesaid.

For some risks, however, Garcia said he saw small but definitesigns of softening. One carrier recently reduced its rates 5% on aprogram providing property and GL coverage. Another reduced thesurcharge it applies for multiple claims to 15% per claim from 25%.It also reduced its surcharge for new ventures.

In commercial P&C, underwriting credits, which werepractically nonexistent in the hard market, are starting to show upagain, Garcia said. He stressed that the situation was nothing likeit was four years ago, when credits of 20% to 25% for cleanaccounts were common. The most available today is 10%, he said,although 5% is more likely.

Commercial auto, where underwriting restrictions that manycarriers put in place two years ago remain, is still in a hardmarket, Garcia said. “There, absolutely nothing has changed,” hesaid, “and we have zip credit authority.”

Garcia said he's beginning to encounter more competition fromstandard insurers. “I'm seeing (St. Paul) Travelers and LibertyMutual, where the last two-and-a-half years, we haven't quotedagainst them on anything,” he said. The competition, he added, iscoming mainly on large monoline property and GL accounts that hadmigrated to surplus-lines carriers during the hard market. Garciasaid that with E&S carriers appearing to stand firm on suchaccounts, standard carriers might be able to get this business backwith relatively small price reductions.

Garcia said most of his E&S carriers have informed him ofplans to grow 10% to 12% in the year ahead, but he predicted itwill be hard for them to achieve sustained growth. Nevertheless,Oklahoma General Agency itself is shooting for a 13.5% increase ingross written premium, which he called “pretty aggressive.”

For the last three years, Garcia and his daughter have made somecalls on retail agents but really have not had a marketingdepartment. That won't get it done, he said, in today's changingmarketplace. “I can see the writing on the wall,” he said. “We'regoing to have to be out beating the bushes, making sure ourcustomers know what we have available and what we can do for them.”In January, Garcia hired a full-time marketing director who hasexperience in a retail agency. “He's going to be able to talk tothem (retail agents) as if he were sitting on their side of thedesk,” he said.

E&S companies, while not budging much yet on rates, havebeen taking steps on the service side to make themselves moredesirable partners, Garcia said. For instance, one of his carriersinformed him of its objective to be the most efficient one he hasfor transacting business. Another is about to go to direct bill, asGarcia said many E&S insurers already have.

As the year goes along, Garcia said he expects E&S insurersto become more competitive. Much as carriers waited to see whowould be the first to raise rates when the market hardened, hesaid, they now seem to be watching for the first to drop them. “Bythe time spring is over, I think there's going to be some looseningof prices,” he said. “I think it's going to become a lot morecompetitive than we've seen in the last three years.”

Nicholas D. Cortezi
All Risks Ltd.

While accounts “at the margin” of the E&S marketplaceincreasingly will be picked up by standard insurers in 2005, thereare still good opportunities out there for brokers and MGAs,according to Nick Cortezi, CEO of All Risks Ltd., in Hunt Valley,M.D., and a former president of NAPSLO.

All Risks, which sells an array of commercial- andpersonal-lines business, functions as both an MGA and asurplus-lines broker. It also operates a number of nationalprograms. It does business up and down the East Coast andincreasingly in the West, where it recently opened offices inCalifornia and Texas. About 80% of its business is nonadmitted, and20% is admitted.

Cortezi said his E&S markets have not informed him of anystrategic changes they plan to implement in 2005. “I think all thecarriers are focusing on trying to keep their renewals in what is aflattening or, in cases, a softening marketplace,” he said, addingthat many nonetheless are still looking to grow. The task, he said,will not be easy, with brokers and insurers pursuing a shrinkingpool of available accounts. “The risks aren't being kicked out ofthe standard marketplace because of underwriting discipline, theway they were,” he said. Among those likely to be wooed back tostandard insurance companies are property accounts, he said, eventhose that have had adverse loss histories.

Cortezi said he so far hasn't noticed any changes incompensation or other incentives E&S insurers are offering forbusiness. He added, however, that when markets have changed to softfrom hard in the past, carriers usually started to pay largerupfront commissions at some point.

Despite the softening market, Cortezi said he was upbeat aboutthe year ahead. “We are looking to add talent as quickly as we canfind talented people,” he said. “We think there is a terrificamount of opportunity on our side of the marketplace.” He said AllRisks is looking for both brokers and underwriters, in part to meetthe organization's growing presence in California, Texas, NorthCarolina and Florida.

All Risks writes a considerable amount of program business,which has experienced difficult times in the past few years. “Theprogram marketplace was hit hard by the market change,” Cortezinoted, “and we were lucky enough to go through it with our programsintact and in some cases in better shape.”

A softening market can be both good news and bad news forprogram business, Cortezi said. As rates stop growing or even startto fall, the profitability of a program may drop “below thewaterline,” he said, not that the program-business market iscurrently approaching such a point. The good news, he said, is thatin a softening market, more carriers see specialty programs as amore likely path to growth than the “generalist approach.”

For Cortezi, the good news apparently outweighs the bad. He saidthat while All Risks normally tries to launch one or two newprograms a year, “we'll probably be rolling out three or four newproducts this year that we'll distribute on a proprietary programbasis.”

Rob Giles
Midwest General Agency

“The market certainly has cooled off significantly,” said RobGiles, president and chief operating officer of Midwest GeneralAgency, who was reached in Phoenix, where he was visiting with anumber of his E&S insurers. Most feel pricing needs to stay atthe level it now is, said Giles, who is a past president of AAMGA.They are concerned, however, that new players that have entered themarket in the past few years, attracted by hard-market rates, maynow cut premiums aggressively to gain market share. Despiteincreased competition from standard insurers and other E&Scarriers, Giles said, most of his insurers have told him they areplanning for 10% to 15% growth in 2005.

Midwest General Agency, located in Eau Claire, Wis., owns FirstWestern Insurance, a general agency in Des Moines, Iowa, andrecently purchased Tower Special Facilities, a general agencylocated in a Milwaukee suburb. Midwest and its affiliates dobusiness in Minnesota and Nebraska, as well as Wisconsin and Iowa.The organization writes a broad mix of business. One specialty islong-haul trucking. The requirement in most states that truckers'commercial auto insurance must be placed in admitted markets helpsaccount for the organization's 60/40 split of admitted tononadmitted business.

One area in which Giles expects more competition from standardinsurers is for recently formed business. In the past three or fouryears, he noted, many start-ups were founded by people who had been“downsized” out of a position or otherwise lost their jobs. “Nowthat they've been in business for three years and have verifiableloss runs, a lot of standard markets are picking them up-which isthe way it's supposed to work,” he said. “We take the new guy onthe block with no experience, and we insure him for a few years.Then he becomes eligible for a standard market.” He said standardinsurers also seem to be showing more interest in technologyaccounts, although Midwest General Agency is not greatly involvedin that niche.

Giles said he certainly continues to see opportunities in theE&S marketplace. For one thing, new businesses continue to beformed. Many professionals and most contractors remain difficultclasses of business, he said, and insurance for both long-haultrucks and heavy job-site trucks remains a specialty. High-limitexcess and umbrella liability policies will continue to be writtenmainly by E&S insurers, he added.

In response to softening conditions, Giles said his organizationis marketing more aggressively. Midwest General has been holdingmore workshops in communities throughout its territory, whereinvited retail agents learn about the organization and the productsit has available. “They've been very successful for us,” hesaid.

“We think that over the last few years, we've really laid thegroundwork with our marketing efforts and with aligning ourselveswith some of the stronger markets in the E&S business,” Gilessaid. He added that pursuing continuing education through the AAMGAUniversity and NAPSLO's educational programs also has been animportant part of Midwest General's preparation. “We're not goingto see the growth we've seen in the last few years,” he said, “butwe think we're still positioned well to grow.”

Tom Comer
Swett & Crawford

At Swett & Crawford, the nation's largest wholesaler,President & CEO Tom Comer said he expects a significantreduction in rates in 2005. Swett places at least 60% of itsbusiness with nonadmitted carriers, he said.

“I see a downturn in rates, say to the tune of maybe 15%,” Comersaid. “We were seeing it already in January.”

Comer said that with many reinsurance renewals still to come in2005, the full impact of reinsurance on the year is yet to bedetermined, but he added that insurance premiums will be comingdown, regardless. “No question about that,” he said.

As standard insurers start opening up their books to businessthey've shunned for the past few years, Comer said he expectssoftening “pretty much across the board, with property leading thepack.” Where rates become unreasonably low, however, E&Scarriers will pretty much let the business flow back to thestandard market, he said. “I think everyone is saying, 'If we canmaintain our book, fine,'” he said. “'If we lose (accounts), we'renot going to jump out the window.'”

For now, at least, E&S insurers are maintaining theirunderwriting discipline, Comer said, “but they're going to struggleto make their margins.”

Kevin Kelley, CPCU
Lexington Insurance Co.

When discussing the E&S marketplace, said Kevin H. Kelley,CPCU, chairman and CEO of Lexington Insurance Company, the nation'slargest E&S insurer, one should keep in mind that there are“markets within the market,” each having a different cycle andbeing at different stages in those cycles.

Kelley called the property-insurance market “veryschizophrenic.” While reinsurers, as a group, are being relativelycautious and are willing to let business go, particularly in areaswith high wind-damage exposure, Kelley said primary carriers seemintent on growing market share. “They are willing to cut rates todo that,” he said. “In many cases, they are willing to stretch intoareas that historically they have not been involved with.”

Kelley said he finds this behavior at odds with last year'shurricane season, which he said caused insured damage estimated atanywhere from $20 billion to $35 billion. One possible reason forthe split between insurers' and reinsurers' actions is that manyreinsurance treaties are yet to renew, Kelley said. As they do, andas primary insurers get a more accurate fix on their ultimatelosses from the four hurricanes that hit Florida in 2004, Kelleysaid there could be a “delayed reaction” lessening the pricecompetition.

Kelley acknowledged that rates for Jan. 1 catastrophereinsurance renewals were flat or slightly lower in most cases,“but you have to keep in mind that, because of the way these fourstorms developed, the losses to the CAT market were relativelysmall. So most of…the loss fell inordinately on the insurers, notthe CAT reinsurers.” Quota-share reinsurers, on the other hand,“got hit with some pretty good losses,” Kelley said. “So I thinkwhat you'll see in 2005 is a reasonably good CAT market, from aninsurer's standpoint, but a much more disciplined propertyquota-share market.” He added that while the market is not pushingfor property-insurance rate increases, as one might have expectedin the wake of the hurricanes, “we are seeing a much smaller ratereduction than we saw throughout 2004.”

So will E&S insurers compete for property insurance or letit return to the standard markets? “I think it will depend on thewind season, which, as you know, starts in July,” Kelley said.Other developments, including an earthquake or “geopoliticalevent,” also could cause the market to “snap,” he said. “I thinkthe property markets are a lot more fragile than maybe some peoplethink.”

Turning to other parts of the E&S marketplace, Kelley saidLexington continues to see “reasonably good opportunities” forwriting casualty insurance, “but there again, we're starting to seesome pressure on rates,” particularly for short-tail risks.Professional liability rates, he added, continue to grow atsingle-digit to low double-digit rates.

Asked where he sees opportunities for Lexington, Kelley citedcoverage for architects, engineers, contractors and health-carerisks. For casualty risks in general, he said, “I think one of thethings we bring to the table…is the capability to write both aprimary policy and an umbrella for the same account.”

Mike Miller, CPCU, CLU, ASLI
Scottsdale Insurance Co.

At Scottsdale Insurance Co., the nation's fourth-largest E&Scarrier, the emphasis in 2005 will be on retaining business andmonitoring the marketplace with the help of its wholesalers, saidMike Miller, CPCU, CLU, ASLI, Scottsdale's president and chiefoperating officer.

Miller said the market hit a plateau, probably in the secondhalf of last year and perhaps earlier for property insurance. “Ourcurrent view of the market is that it's fairly stable,” he said.“We don't see opportunities for any kind of meaningful rateincreases, and certainly there is some downward pressure in certainlines of business.”

Like many others interviewed for this article, Mill